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  • Foundations and Trends R inEntrepreneurshipVol. 8, No. 4 (2012) 279342c 2012 M. Scarlata, L. Alemany Gil and A. ZacharakisDOI: 10.1561/0300000042

    Philanthropic Venture Capital:Venture Capital for Social Entrepreneurs?

    By Mariarosa Scarlata, Luisa Alemany Giland Andrew Zacharakis

    Contents

    1 Introduction 280

    2 Philanthropic Venture Capital: Definition 283

    2.1 Venture Capital 2872.2 Philanthropic Venture Capital 289

    3 The Landscape of SocialEntrepreneurial Financing 291

    3.1 Typologies of PhVC Investments 293

    4 Philanthropic Venture Capital: Current Status 302

    4.1 PhVC in the United States 3044.2 PhVC in Europe 305

    5 Investment Practices: Philanthropic VentureCapital vs. Venture Capital 308

    5.1 Deal Origination 310

  • 5.2 Deal Screening and Evaluation 3145.3 Deal Structuring 3195.4 Post-Investment Activities 3225.5 Exit 328

    6 Conclusions 331

    References 334

  • Foundations and Trends R inEntrepreneurshipVol. 8, No. 4 (2012) 279342c 2012 M. Scarlata, L. Alemany Gil and A. ZacharakisDOI: 10.1561/0300000042

    Philanthropic Venture Capital:Venture Capital for Social Entrepreneurs?

    Mariarosa Scarlata1, Luisa Alemany Gil2

    and Andrew Zacharakis3

    1 Newcastle University, UK, mariarosa.scarlata@newcastle.ac.uk2 ESADE, Spain, luisa.alemany@esade.edu3 Babson College, USA, zacharakis@babson.edu

    Abstract

    Since social entrepreneurship is a relatively young activity, resource-rich actors, like Philanthropic VCs, have considerable influence overhow the space matures (Nicholls, 2010b). The resources and strategicadvice that PhVCs provide their SEs shape an institutional logic forthe domain. As such, PhVCs enhance legitimacy of the emerging areaof social entrepreneurship. This monographs main contribution is todelineate the current state of PhVC, identifying differences with tradi-tional VC financing, and identify areas of future research. In particular,this work responds to Nicholls (2010b) and Austin et al.s (2006b) callfor research on what types of finance SEs have access to. More specif-ically, we focus on understanding what PhVC is and how its socialvalue creation investment logic makes it different from traditional VC,opening avenues for future research in this area.

  • 1Introduction

    Philanthropic venture capital (PhVC) is an innovative funding modelavailable for social enterprises (SEs) which provides a blend ofperformance-based development finance and professional services toorganisations with a primary social mission. PhVC seeks to maximizethe social impact of the investee through the provision of capital andvalue-added activities, as typically done in traditional venture capi-tal (VC) financing. The main difference between PhVC and traditionalVC lies in the investment goals. Whereas traditional venture capitalists(VCs) work to grow each of their portfolio companies and ultimatelyseek a large financial return upon a liquidity event (most often an Ini-tial Public Offering [IPO] or acquisition), PhVC have both economicand social goals. Specifically, philanthropic venture capitalists (PhVCs)work to develop self-sustaining SEs assuming that sustainability facil-itates long-term organizational survival, growth and ultimately maxi-mization of their impact on society (Letts et al., 1997).

    The importance of SEs has been growing both in the professionaland academic sectors over the last decade (Bosma and Levie, 2010;Harding, 2007, 2004; Roberts and Woods, 2005). In particular, Bosmaand Levie (2010) report the average rate of social entrepreneurial

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  • 281

    activity across the countries participating in the Global Entrepreneur-ship Monitor amounts to 1.8 percent of the total adult population;within the United Kingdom, Harding (2007) reports that the rate was3.3 percent in 2006. While explaining social entrepreneurship trends,Cox and Healey (1998) indicate that in Europe, SEs have a key role inwelfare and environmental policy innovation, whereas Mair and Seelos(2007) as well as Prahalad (2006) argue that in developing countries,social entrepreneurship tends to address compelling social problems,such as hunger, disease and education, through the application ofinnovative and cost-effective methods to traditional solutions. At theresearch level, Short et al. (2009) show that the publication rate ofresearch articles on social entrepreneurship, subject to a double-blindedreview process, has increased by 750 percent between 1991 and 2009.

    On the academic side, the bulk of research has sought to definewhat an SE is and how it differs from traditional commercial ventures.In doing so, social entrepreneurship has been presented as a new modelof systemic social change (Bornstein, 2004; Nicholls, 2010b), the solu-tion to government failures in welfare provision (Aiken, 2006; Bovaird,2006), a new market opportunity for business (Prahalad, 2006), a modelof political transformation and empowerment (Alvord et al., 2004), anda space for new hybrid partnerships (Austin et al., 2006a).

    Despite the growing importance, SEs still struggle to secure exter-nal sources of finance. SEs must deal with the Pareto assumption thatachieving a social and/or environmental return inevitably reduces eco-nomic returns for investors. Financial economists suggest that invest-ments can only be differentiated based on their risk-return profile withsocial or environmental factors being presented as externalities (Arrowand Fisher, 1974; Freidman, 1962). This, in turn, leaves no room inthat research sphere for the existence of investments in organizationswith social aims, such as SEs. Also, the inability to get financing mightconstitute the single biggest barrier to establishing an SE (Bank ofEngland, 2003). Other research also finds that access to finance is themain barrier to SEs growth (Harding, 2007; Smallbone et al., 2001;Conaty, 2001).

    PhVC helps overcome the financing access problem, because it com-bines a for-profit focus on efficient use of economic resources with the

  • 282 Introduction

    nonprofit proposition on social value creation (Austin et al., 2006a).Rather than providing funds to single projects with a short-term invest-ment period, as typically done by foundations or government grants,PhVC commits to long-term funding in order to build the capacity ofthe SE to become sustainable, grow, and ultimately maximize its socialimpact. However, the mere provision of capital is not enough for sus-tainability and growth; financial resources must be accompanied by theprovision of value added activities and a high level of PhVC strategicengagement. For instance, PhVCs typically sit on the board of the SEsthey back and advise the entrepreneurs on how to grow.

    Since social entrepreneurship is a relatively young activity, resource-rich actors, like PhVCs, have considerable influence over how the spacematures (Nicholls, 2010b). The resources and strategic advice thatPhVCs provide their SEs shape an institutional logic for the domain.As such, PhVCs enhance legitimacy of the emerging area of socialentrepreneurship. This monographs main contribution is to delineatethe current state of PhVC, identifying differences with traditional VCfinancing, and identify areas of future research. In particular, this workresponds to Nicholls (2010b) and Austin et al.s (2006b) call for researchon what types of finance SEs have access to. More specifically, wefocus on understanding what PhVC is and how its social value cre-ation investment logic makes it different from traditional VC, openingavenues for future research in this area. We do not cover how PhVCsraise their funds as we are interested in the relationship between thephilanthropic investor and the SE.

    The monograph is structured as follows. First, a definition of PhVCis proposed. Second, an overview of financing available for socialentrepreneurs is discussed focusing on those characterized by a levelof investor engagement. Third, data on the PhVC sector in the UnitedStates and in Europe is presented in terms of age of the sector, legalform of the PhVC firm, capital under management and location of port-folio organizations. Forth, investment practices implemented in PhVCare identified according to the different phases of the investment pro-cess in traditional VC and further research opportunities are identified.Last, the paper draws conclusions and implications for academics andpractitioners.

  • 2Philanthropic Venture Capital: Definition

    The PhVC industry emerged in the late nineties (Letts et al., 1997)in the United States, quickly spreading to Europe. PhVC is a financ-ing model available for social entrepreneurs that channels financialresources from donors/investors to SEs and, like conventional investors,focuses on an efficient, market driven process of value creation.Although social entrepreneurship research is still in a pre-paradigmaticstatus (Nicholls, 2010b) resulting in a lack of consensus on the meaningof the term (Dacin et al., 2010; Nicholls, 2010a,b; Short et al., 2009;Zahra et al., 2009), social entrepreneurship is here defined as anyinnovative action that individuals, organizations, or networks conductto enhance or reconfigure existing institutional arrangements to addressthe inadequate provision, or unequal distribution, of social and environ-mental goods (Nicholls, 2009, p. 755). To this definition, we also addRobinson (2006) as well as Emerson and Twerskys (1996) view thatsocial entrepreneurship happens when economically sustainable ven-tures through the adoption of market-based approaches generate socialvalue. As such, social entrepreneurship is not bounded by the legal formthe organization undertakes: SEs can be legally structured as nonprofitor for-profit enterprises.

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  • 284 Philanthropic Venture Capital: Definition

    While trying